Wal-Mart Continues To Progress

On January 7th I posted an article about Wal-Mart (NYSE:WMT). Since then, the stock is up 6.8%. The S&P 500 is up 3.0% over the same period. In this post, I outlined the major investments the company is making in its employees and technology. Additionally, I analyzed the competitive environment that the company operates in and why I believe Wal-Mart will be successful. If you would like to read the post, you can find it here.

Since this post we have seen Wal-Mart continue to execute its strategies. On January 15th the company announced that it would be closing 269 stores, of which 154 are in the U.S. Many people were surprised and saw this as a worrisome development. However, I view this as normal operations for a mature retailer. Wal-Mart has over 11,500 stores so it shouldn’t come as a huge surprise that they close a few each year. As an investor, I like to see management focusing on effective operations and closing underperforming stores. These store closures only account for about 1% of total revenues. The real information in these store closures was that Wal-Mart decided to close down the Wal-Mart Express stores. These were small size stores that mostly competed with Dollar Tree (NASDAQ:DLTR) and Dollar General (NYSE:DG). These small format stores were not profitable and targeted urban areas. Personally, I think this was a good business decision. As large as Wal-Mart is, this was more of a trial run to see if this concept would be effective. I don’t think it fits in with the long-term strategies of the company.

Store Productivity

One of the best retail turnarounds since the financial crisis was at Home Depot (NYSE:HD). This company took a huge hit after the housing bubble burst and CEO Frank Blake did a terrific job turning the company around. The stock went from $29 in August 2011 to north of $130 today. I think it is worth noting the strategies that were so effective for Home Depot and comparing them to Wal-Mart’s today. CEO Frank Blake leveraged three strategies that worked incredibly well:

Reduced store openings. HD went from expanding its store base by 5-6% each year to less than 1% each year.

When I used this as a case study, I noticed many similarities between HD then and WMT today. Wal-Mart seems to be focused on creating a better shopping experience by improving inventory management and customer service. They are investing in their employees by boosting wages and increasing training so employees can offer a better customer experience. Employees are receiving more training than they ever ranging from customer interaction to using new technology. Traffic and sales comps continue to be positive with traffic up 0.7% and sales comps up 0.6% in Q4. The company is focused on running existing stores more efficiently and closing those that are not productive. Wal-Mart also continues to buyback large amounts of stock. They will purchase $2 billion in stock over the next two years. I think these strategies will prove to be successful.

E-Commerce

Many analysts are disappointed with the growth of Wal-Mart’s online presence. However, Wal-Mart is actually growing its online sales at about the same pace as Amazon (NASDAQ:AMZN) did when it began online sales. Investors think that Wal-Mart should be growing its online sales as fast as Amazon or it is a failure. I would disagree with this assumption. First, the infrastructure must be built in way that will be highly profitable for Wal-Mart. I think people forget that Amazon still doesn’t make money. WMT continues to build fulfillment centers around the world and is continually improving its online platforms. About 70% of online sales in Q4 were executed on a mobile device. WMT grew ecommerce sales by 12% in FY 2016. The ecommerce industry is growing at about 16% but expected to have a 12% CAGR into 2020.

Analysts and investors widely believe that Amazon has taken a lot of business away from Wal-Mart. However, about 56% of Wal-Mart’s sales are grocery and I know that I am not buying milk and bread on Amazon. I don’t know anyone that is. Wal-Mart’s grocery business is actually thriving with Neighborhood Market comps up 7%. I will admit that Amazon has taken a small amount of business away but I don’t think it is anywhere near what people are estimating. The major battleground over the next five years will be online grocery and grocery delivery. We are beginning to see this trend develop however it is certainly not a widespread phenomenon. I think people are underestimating the power of WMT. The company can absolutely compete with any other grocery delivery service just by using the existing stores as warehouses. I don’t think it would be difficult to have employees fulfill online orders and deliver them quickly. Even within two hours for most customers. I believe this is the direction the company is heading and I think it is probably the only retailer that can beat Amazon. In Q4 WMT announced that is saw a 46% increase in Sam’s Club grocery pickup which is the fastest growing part of the business. Customers are beginning to experiment with online grocery but 93% of grocery sales still occur in brick and mortar stores. Here is breakdown of a survey performed by Cowen indicating potential online grocery sales by demographic.

It is not surprising that the younger demographics are driving the change. I think we are a few years away from a point when 35-40% of all grocery are executed online. I think Wal-Mart will be in an excellent position to compete with Amazon for this business. With the amount of potential distribution centers and the massive quantities sold, I see economies of scale working in their favor.

Conclusion

Wal-Mart continues to invest in growth and execute their strategies. The company has now seen six straight quarters of positive comps. As time goes on, more customers will shift to their digital platforms. When customers use digital platforms they are expected to purchase 15-20% more than they would in store. Additionally, as less people shop in stores, it will make for a more pleasant shopping experience for those who still do.

Many analysts fear the company’s contracting U.S. operating margins. However, I believe this is transitory and will reverse once the digital infrastructure is in place. It is worth noting that margins at Sam’s Club and the international segment have been positive in terms of y/y growth in three of the last five quarters.

The stock pays a nice dividend that yields just shy of 3% and the stock continues to trade at a fair price. I think it will take potentially several years to see the company’s digital strategies unfold. I think we will see a lot of things change over the next few years. Customers today are thrilled about being able to pick up their groceries without getting out of their cars. Just wait until they won’t even need to drive to the store to pick them up. I think investors have a lot of things to look forward to with this company.